"[Portfolio 21] is looking vertically throughout the entire company to see how sustainability ripples through every level of decision making," Kramer says. "They look at how seriously and quickly a transition is happening, even though some of the names they pick wouldn't be the kind that are necessarily green. It's the commitment the company is making to transform itself largely driven by cost savings as well."
The fund identifies the most critical issues facing a company and sector, and considers what a company should be doing in terms of its material ecological risks and core business. Is Google, for example, serving organic food in its cafeteria and recycling paper but ignoring the supply of power that is key to its survival? Portfolio 21 scores Google using its qualitative descriptors, but weighting those that are core to Google's business.
How does this work? Take "life cycle analysis." A company receives the highest score if it designs every product with a "cradle to cradle" approach, meaning a product has been designed so that its materials can ultimately be re-used or are biodegradable and organic if they end up as waste. It receives a zero if it doesn't have a clue what life cycle analysis is.
"We're able to take qualitative input and turn it into a quantitative score that helps us rank different companies," Christian says. "And now there's more quantitative information available that allows us to compare companies, particularly within sectors as to their relative performance."
In this way, Portfolio 21 does not measure ecological risk so much as gauge it. "In the face of ecological limits and all the uncertainties around that, it is no longer possible - even if it was in the past-to accurately gauge a probability distribution," Christian says. "Volatility is the attempt to express risk as one number. But if you focus in on only those things that you can prescribe a distribution to, you are going to miss the huge game-changers."
This is profound. Thanks to computers, after all, Wall Street has come to be dominated by quantitative investment management. There is a staggering amount of data available, along with providers galore that will crunch the numbers. Investors compile this information, using it to create mathematical algorithms for high-frequency trading or to construct portfolios. But while this would seem to make for an "efficient" market due to the accessibility of so much information, most investors have a very siloed approach. "Data points become very much the black box of financial data," says Nick Robins, head of the HSBC Center for Excellence. "But they know little about how that data was derived."
The investment landscape, in other words, has been reduced to a situation where few investors understand their investments. Beyond that, says Christian, there's a growing gap between what the "most thoughtful and intelligent" companies are doing relative to those that are "in denial" about ecological limits. "The research has to be qualitative and granular," she says. "You've got to dig in and poke around. Looking at data feeds alone does not give you that perspective."
For the fund, information gathering is a continuous process. Although its analysts use data the fund purchases, they supplement that with information gleaned from Web sites and other sources they trust, including NGOs like the Silicon Valley Toxics Coalition, Health Care Without Harm, and the Rainforest Action Network. If, based on its initial analysis, it likes what it sees, it probes deeper into a company's actual operations. Business models are key, and the fund puts a greater weight on companies that try to get their sourcing and distribution channels more concentrated. It also looks for distributed decision-making so that teams can make decisions on the production line, something Christian argues is more efficient than having to stop an entire assembly line or work chain and re-tool it and shift.
"The eco-systems people talk about resilience, redundancy and complexity, and [others] talk about efficiency and lean," she says. "But there's overlap. Efficiency doesn't necessarily mean just-in-time [manufacturing.] You are creating an environment where people are problem solving and suggesting continuous improvement. Which makes sense -- it's what nature does without having a team to talk about it."
Another key factor: if companies are actually spending their money in alignment with their stated principles regarding ecological limits. If it's an oil company, for example, are its R&D and M&A activities going into renewable energy rather than fossil fuels?
"To a certain extent, BP [Deep Horizon] was a tail event," she says. "If you had done ESG [environmental, social and governance] analysis, you would have seen these problems. As for us, we did not invest in the company because BP was not investing in renewables to any degree. It was making a big display, but [its investment] was a tiny amount relative to their overall revenues. The bulk of their money was going into oil exploration."
While the fund has not been invested in oil (the key reason Christian cites for not beating its benchmark last year, for the first time in a decade), it's actually going to look at a non-U.S. oil company because there are rumblings it may be serious about renewable energy. "When people think of negative screens, they think it's an ethical decision," she says. "But that's not what these are. The only real ethical issue for us is weapons and military warfare."
In fact, the fund has what might seem to be an extraordinary list of negative screens. To begin with, it does not invest in companies that use genetic engineering for agricultural applications, though industrial applications are OK and it will consider medical applications. Even so, it does not allow for bio-piracy, a situation where indigenous knowledge is exploited often resulting in patents on life. The fund insists on a fair allocation of profits to local communities from which genetic materials have been obtained.
Nor are there companies that derive more than 5 percent of revenues from nuclear power, or those that operate in countries that are state sponsors of terrorism. It screens out companies with negative performance in employee relations, human rights, community involvement and product safety-conditions that could violate peoples' capacity to meet their own needs. And it avoids tobacco and gambling.
The fund's Web site is an extraordinary model of transparency that sets the bar for communicating in depth about how a fund thinks, invests, makes decisions, and votes its proxies. It profiles every company it invests in, along with its sustainability pros and cons. It explains why it does not invest in various companies and why it divests, a rationale that is often market-related. It also describes its policies on nuclear power, biotechnology and human rights and social justice.
Since its screens are not ethical, Portfolio 21 does not fit into the traditional box of socially responsible investment, as it's often perceived. But it doesn't practice the value-driven "best-in-class" approach to responsible investing favored by institutional investors either, whereby a fund might choose the best performer in its sector with respect to ESG factors in an effort to maintain the sector-driven diversification commonly associated with Modern Portfolio Theory.
"If we can't find a company that meets our criteria in a particular sector, then we're not in that sector," Christian says. "We're not in oil, airlines or commodities right now. Which is a challenge because in the short-term, you can make a lot of money by being invested in scarce resources."
As a fund focused on sustainability, Portfolio 21 is by definition a long-term investor. As such, it has a low turnover of shares of 10 percent per year. But the elephant in the room, the issue that Christian grapples with, is the limits to economic growth imposed by a dwindling supply of finite resources. Her concern: The market is totally reliant on growth, something that is perpetuated by the financial mess we're in. Growth has promoted globalization and "throughput" (material and energy flowing into waste)-something that has been inefficient.
How has globalization created an inefficient global economy? Think of it this way. Globalization is only efficient when energy and labor are cheap, and there is no scarcity or limit on resources. But there is a limit on resources, and prices have not reflected their scarcity based on using them in a sustainable manner-that is, based on our living on ecological income rather than robbing our natural capital principal, which itself has eroded to a dangerous degree. As a result, we now face uncomfortable trade-offs like food versus fuel. Or, we can obtain the fuel-but only by depleting the water supply or even poisoning it.
The upshot: The global economy, as currently organized, is a giant ecological bubble primed by artificially low prices of the fundamental resources upon which the entire system depends.
"The temptation is to say that we can keep growing for quite a while until we reach the limit but we're not there yet," Christian says. "But we are hitting those limits: water, for example. We see them primarily in marginalized economies, but they are not yet affecting the bottom line."
Another sign that we have already reached ecological limits: the BP Deep Horizon accident. There's still oil, but it's more difficult to get. "They were drilling two miles under the ocean, so there's more risk involved than there used to be," says Christian, who believes the Black Swan fixation is a response to uncertainty and fear-an explanation for not facing limits. "We've seen financial meltdowns before, and we've seen oil spills before. We've seen nuclear plants fail. I don't see them as Black Swans. We like to say they are so that we can in a sense let ourselves off the hook for not looking holistically at the mess we're in."
In her blog posts about Modern Portfolio Theory (MPT), Christian argues that we have come to equate risky behavior - by oil companies that engage in riskier exploration and production, for example-with "prudent" investment management. MPT, of course, encourages diversification, and most investors interpret that to mean that they should be invested in every sector. The focus on shareholder value, she says, has also encouraged companies to engage in risky behavior and investors to overlook it. As such, she believes, the assumptions inherent in MPT-growth, globalization and historical trends-are questionable.
"Rather than trying to measure the riskiness of a particular asset within the framework of a growth economy that looks a lot like the past century but with more players," she writes, "perhaps we need to consider the riskiness of the global economy itself."
As a result, Christian writes, it's no longer "prudent" to place "all of one's eggs in the global basket" -she recommends making investments in local communities as well as impact investments. (See: The New Candy, March.) Portfolio 21, of course, is a global fund invested in large companies-40 percent in the U.S. It continues to focus on essential services like infrastructure, renewable energy, efficiency and health care-those, of course, with business models that in effect emphasize local communities by re-modeling their logistics. It's also looking to invest in companies that pay dividends (meaning they are not as focused on growth) and for smaller companies, as well as in places like Brazil where there is more growth. It supports Calvert Foundation's community investment notes, a well-regarded impact investment. And if all goes as planned, it will even make a private equity investment in a bank focused on sustainability, an impact investment in which only accredited investors can usually partake.
But while Christian says the idea of a no-growth economy is gaining traction among the fringe (she's currently reading Paul Gilding's The Great Disruption and Richard Heinberg's End of Growth), she does not believe the world will catch on. "If the whole world woke up and said it's the end of growth, the stock market would crash," she says. "But it's too hard to let go of the idea of growth, and there are pockets of growth continuing."
And there is hope on the horizon. Oil prices are beginning to rise, meaning that companies (and the rest of us) will be forced to "internalize the externalities," meaning we will pay the true cost of obtaining and using these resources. "In my opinion," Christian says, "that's the only thing that will turn things around."
A former investment banker and veteran financial journalist, Ellie Winninghoff writes a blog at: www.dogoodcapitalist.com. She can be contacted at: [email protected].